Ride the Right Bull!

Puru Saxena
20 December 2006

CURRENT SITUATION - The financial markets continue to power
ahead. Stocks are rising, commodities have begun the next advance
in their bull-market and even the bond-market is strong! It seems
that investors in every asset-class are convinced about the soundness
of their judgement, but history reminds us that someone will
be very wrong!

So, are the bond investors
being fooled into believing that inflation isn't a problem? Or
are the equity punters wrong about the coming interest-rate cuts
and a soft landing in the US? Perhaps, the commodities camp is
naïve and we are in fact witnessing a gigantic bubble in
natural resources.

Amidst all these diverse views,
my own money lies in the inflationary camp (commodities and emerging-market
equities) and I suspect that the bond-investors will be the ones
who get badly hurt. After all, central banks around the world
continue to churn out a ridiculous amount of paper, otherwise
known as money. Inflation (money-supply and credit growth) is
spiralling out of control and all this excess liquidity is causing
prices to rise all around us, thereby diminishing the purchasing
power of our savings. So far, central banks (through their propaganda
and skewed inflation figures) have managed to keep the public's
inflationary fears under check. However, once the masses wake
up to the inflation menace, there will be a stampede out of "paper"
causing interest-rates to soar and the bond-market will sink
like a rock. The same drama unfolded during the 1970's and I
suspect history will repeat itself over the coming years.

Those who believe in a deflationary
collapse don't understand our monetary system. Today, central
banks have the freedom, the ability and the motive to print an
endless amount of money, which will avoid any deflationary bust-ups
at least in the immediate future. A more likely outcome is that
thanks to the money-printing prowess of Mr. Bernanke and his
counterparts elsewhere in the world, the purchasing power of
all the "paper" currencies will continue to fall against
tangible assets and eventually the entire monetary-system may
come into question.

You must understand that banks
are in the business of lending money and inflation benefits them
immensely. The higher the rate of inflation (money-supply and
credit growth), the bigger their profits from collecting interest
on the issued loans. Moreover, inflation also keeps a segment
of the public happy (at least those who have the ability to invest)
as their assets continue to rise, thereby giving the illusion
of prosperity. So, the hidden agenda of the central banks and
politicians is to create and encourage inflation, whilst telling
the public that they are in fact fighting inflation! I may add
that during highly inflationary times, it is always the majority
of the public which suffers badly as their savings, incomes and
pensions continue to erode in value. So, in order to protect
your wealth, you must avoid the "safe haven" of cash
and invest in assets that are likely to benefit from the ongoing
monetary insanity.

These days, the consensus view
is that the interest-rate in the US will fall over the coming
months as the Federal Reserve steps in to support the US economy.
In my view, the Fed Funds rate may actually rise around April-May
next year.

Firstly, despite the hikes
since 2004, the Fed Funds rate is still close to the bottom of
its 30-year range (Figure 1). So, the notion that the interest-rate
is "too high" is totally absurd. In fact, I would argue
that given the degree of inflation we have seen in the US since
2001, the Fed Funds rate is shockingly low!

Figure 1: Fed Funds
rate still extremely low!

Source: Economagic

More importantly, if my assessment
about the markets is correct, commodities (especially gold and
silver) will advance over the coming months and test their highs
recorded earlier this year in May and the US dollar will decline
to its low recorded in December 2004. Such an outcome will cause
inflationary fears to return with a vengeance and the Federal
Reserve will raise its interest-rate.

The prime objective of any
central bank is to protect its merchandise (the currency it issues)
and the Federal Reserve will do everything in its power to prevent
a total collapse of the US dollar. In theory, a higher yield
is supposed to make a currency more attractive, so the Federal
Reserve is likely to increase the interest-rate at the cost of
the US economy. Such an unexpected move will probably send the
financial and property markets into yet another painful correction
phase during the next summer.

On a brighter note, we still
have a good stretch ahead of us and I expect the markets to remain
strong until towards the end of the first quarter next year.
At this stage, our managed accounts are fully invested in the
commodities complex and emerging-markets. However, depending
on the market conditions prevalent early next year, we will start
to lock-in our gains by going into money-market funds and bonds
for a few months.

The above is an excerpt
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Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.

Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.